Moving Average Convergence/Divergence (MACD) is a powerful trend-following indicator that helps traders spot potential buying and selling opportunities by examining the relationship between two Moving Averages of a price.
The MACD is derived from the difference between the 12-period and 26-period exponential moving averages (EMA). To make it easier to identify buy and sell signals, a signal line, which is a 9-period moving average of the MACD itself, is plotted on the MACD chart.
This indicator shines in volatile markets and can be utilized in several ways: through crossovers, identifying overbought/oversold conditions, and spotting divergences.
- Crossovers: The fundamental MACD strategy is to sell when the MACD dips below the signal line. Conversely, a buy signal occurs when the MACD crosses above its signal line. Many traders also consider buying or selling when the MACD crosses the zero line.
- Overbought/Oversold Conditions: The MACD is handy for spotting overbought or oversold conditions. If the shorter moving average moves significantly away from the longer moving average (i.e., the MACD rises sharply), it suggests that the security price might be overextended and is likely to revert to more normalized levels.
- Divergence: A divergence between the MACD and the security price can indicate a potential reversal. A bullish divergence occurs when the MACD makes new highs while prices fail to do the same, signaling a possible upturn. Conversely, a bearish divergence happens when the MACD posts new lows while prices do not, hinting at a potential downturn. These divergences are particularly meaningful when they occur at overbought or oversold levels.
MACD Indicator
How to Calculate the MACD:
To calculate the MACD, subtract the value of the 26-period EMA from the 12-period EMA. Then, a 9-period simple moving average of the MACD (the signal line) is plotted on top of it.
MACD = EMA(CLOSE, 12) - EMA(CLOSE, 26)
SIGNAL = SMA(MACD, 9)
Where:
- EMA - Exponential Moving Average;
- SMA - Simple Moving Average;
- SIGNAL - the indicator's signal line.
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